When the world almost ended

It’s 10 years since the global financial system almost sent the world into a great depression. Yohann Koshy takes stock of what went wrong and where we are now

This moment – a decade since the global financial crisis – is an ellipsis. We are between destinations, with no reliable map and uncertain co-ordinates. In September 2008 the fourth-largest US investment bank, Lehman Brothers, founded in 1850, filed for bankruptcy. It looked as if the global financial order, even capitalism itself, was next. Mohamed El-Erian, CEO of PIMCO, a large US investment management firm, asked his wife to withdraw as much money as possible from the ATM in case the banks didn’t open.1 An anonymous hedge fund manager in New York fired off a short email to a journalist: ‘It feels a little like the end of the world.’2

Global seismic events like those of 10 years ago are revelatory because the interests of power become nakedly clear

The world almost did end. And everything stayed the same. Time was borrowed in the form of nationalizations, cash injections and money-printing: space for the financial sector to breathe. But the air is thinning again. Mainstream economists and central bankers speak in strident tones of catastrophes on the horizon. Before we think about what happens next let us remember how we got here. We might have watched a few documentaries or read a few non-fiction bestsellers when it was all going down. But that was so long ago. It had something to do with the US housing market, right...?

Acceptable in the noughties

A useful starting point is the early 2000s. In the wake of the dotcom bubble bursting and the 11 September attacks, the US central bank cut interest rates to stimulate economic activity and avoid a recession. This meant it was cheap for financial institutions to borrow and expensive for money to rest idle. Mortgage lending increased, particularly to working-class black and Latino households, which were often offered low-interest deals that were then adjusted upwards to become more expensive. Rising house prices and cheap consumer imports from the Global South sustained the illusion of good times; it didn’t matter that wage growth was sluggish because families could remortgage homes to pay for consumption.

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The spending spree was nourished by the Global South in another way, too. After the financial crises in Asia in the 1990s, developing world governments, smarting from experiences with the IMF and World Bank, started ‘self-insuring’: keeping reserves of the safest global currency – the US dollar – in case another crisis should lead to sudden outflows of capital. China, with a booming export-based economy, was the most prominent buyer of dollars in the form of US Treasury bonds, bills and stocks. ‘China’s savings, in other words, were parked in the United States, and it was incumbent on us to spend them,’ writes US journalist and novelist Keith Gessen.2

Glossary

Bonds

A promise to pay whoever buys it a certain sum of money each year and to return the whole sum after a pre-determined period. Government spending is often carried out by issuing bonds, called Treasury bonds in the US and gilts in the UK.

Collaterized Debt Obligations (CDO)

A type of security which is sold to investors. The bank still collects mortgage payments, for a suitable fee, and passes them on to the owners of the CDOs. But the loans are no longer on the bank’s balance sheet. It doesn’t take many mortgage defaults for these securities to trigger a financial panic.

Credit Default Swaps (CDS)

A type of derivative which is an insurance policy for people who hold risky bonds. A cautious lender can pay someone else to remove the risk of someone defaulting on a bond for an annual premium – the CDS. It allows speculators to bet on the fragile health of companies who issue bonds.

Derivatives

Financial assets that are ‘derived’ from other assets. They allow for easy speculation. For example, if you want to bet on the price of oil you can either buy a barrel of oil for $100 or buy a derivative on oil, which allows you to make the same bet for only a few dollars. They were heavily regulated in the US before the 1970s.

Fictitious Capital

Whereas ‘fixed capital’, like factories, creates value when combined with the labour of workers, fictitious capital – ‘debts, shares and a diverse array of financial products whose weight in our economies has considerably increased’ – seemingly creates profit out of nothing by ‘staking a claim over wealth that is yet to be produced’.4

Hedge funds

Bet on derivatives and ‘short’ shares that they think will fall in value. Their investors include wealthy individuals, large institutions like universities, and possibly your own pension. A big part of the ‘shadow banking’ world.

Interest Rates

The charge for renting out money. The base rate is set by central banks. Banks set their own higher rates to cover expenses, the likelihood of default and the desired profits.

Securities

Anything that produces a fairly predictable flow of income, like mortgages, can be used as a security. ‘Asset-backed’ refers to, for example, the houses that the flow of income is supposed to be paying for.

This meant that suspiciously easy mortgage deals were going to any American, whatever their ability to honour repayments: NINJAs – mortgage recipients with ‘No income, No Job, No Assets’ – became the lenders’ wicked moniker for subprime borrowers. Wall Street ‘securitized’ this torrent of mortgages into ‘paper’: bonds which were then sold on for a commission, bouncing between investment banks and hedge funds, supposedly diluting the risk. A win-win situation. The mortgage market lifted off from the real world and acquired a life of its own, cruising on the fumes of these asset-backed securities.

Soon homeowners started defaulting on repayments and house prices dropped. Because the mortgages had been bundled into complex products and scattered across the global banking system, the defaults spread like a contagion, and no financial actor knew where responsibility lay. In 2007, inter-bank lending dried up as banks realized they had ‘no way of valuing the more exotic assets on their books’.3 In 2008, Merrill Lynch announced it would be ‘writing down $8bn of subprime-related assets’.2 High net-worth investors, who kept their money in the shadow banking sector (see ‘Shadow Banking’, page 21), got spooked and demanded their money back. According to the economist Gary Gorton, the 2007-08 financial crisis was really an old-fashioned bank run: about $1.2 trillion was withdrawn from the shadow banking sector over the period.

According to US federal reserve chief Ben Bernanke, testifying to the US Financial Crisis Inquiry Commission, 12 of the 13 largest financial firms in the US were about to fail. In Britain, banks that had been conducting their own securitized adventures were bailed out; Icelandic banks, frozen by foreign liabilities, almost took the country under; and the Eurozone soon noticed it was knee-deep, as some of its banks had leverage ratios – the difference between amounts borrowed and held in capital – worse than America’s.3

Something for nothing

This is just a short-term account. To understand why mortgages were turning into exotic abstractions we need to step back to see the outlines of ‘financialization’.

The post-War era in Europe and the United States, between the mid-1940s and early 1970s, was the longest without an observable financial crisis for two or three centuries. The financial architecture of this period was written at a meeting of the world’s bigwigs at a hotel in Bretton Woods, New Hampshire in 1944, as the United States was emerging victorious from the Second World War. The only major economy untouched by conflict, the US decided it would, along with a rebuilt Germany and Japan, produce commodities for the world to consume through its industrial base and, at the same time, ‘dollarize’ Europe. European currencies would be pegged to the value of the US dollar, which itself was linked to the literal quantity of gold held at Fort Knox and under the US Federal Reserve. This ‘gold standard’ forced discipline on the financial system: it was much harder for banks to create credit out of thin air. But it was also unsustainable, and when President Nixon ended the gold standard in 1971, he inaugurated the era of financialization.

The global economy since 2008

Licence to print

Quantitative easing (or QE) has been carried out by central banks to provide easy credit. It involves central banks buying government debt, which reduces the costs of borrowing money for financial institutions. It is sometimes referred to as ‘printing money’ and now plays an unprecedented role in propping up finance:

More than $10 trillion has been added to the balance sheets of the four largest central banks since the crisis through QE. Between March 2015 and September 2017, the European Central Bank added $2.3 trillion to its balance sheet. That’s the same amount of value that the 1.3 billion population of India produces economically in an entire year.

All play and no work

You might have thought there would be fewer unproductive financial activities going on since the crisis. Not so: take 2015. In that year, US private domestic investment increased by $93 billion. However, US corporate debt increased by $793 billion. ‘This suggests that the $700 billion difference was used for unproductive, speculative activities,’ according to economist Ann Pettifor.1

Instead of investing, corporations are increasingly using their cash to buy back their own shares to artificially inflate their value – earning a quick buck for executives. In 2016, Goldman Sachs forecast that the top 500 companies were going to spend $780 billion on buybacks in 2017 – a new record. In 2014, IBM was spending more on share buybacks than on research and development.

China takes charge

While the West stagnates with debt and low growth, the Chinese economy has stepped up:

★ In 2009 a $600 billion dollar government stimulus is credited with rescuing the global economy.

★ Between 2011 and 2013, China poured more concrete than the US poured in the entire 20th century: 6.6 gigatons compared with 4.5 gigatons.

★ Between 2009 and 2010, two state-controlled Chinese banks lent more to the developing world than the World Bank: $110 billion versus the World Bank’s $100 billion.2

In this second period, the US and UK would concentrate far less on producing goods; they would use their financiers in Wall Street and the City of London to recycle the profit surpluses created by the production of goods in other countries. The path for this was cleared by deregulation and the creation of new financial markets, notably in Britain with the abolition of currency exchange controls and Thatcher’s ‘Big Bang’ reforms of 1986. Working class power and wages were stifled with anti-union assaults not just in the US and Britain but also in countries as varied as Canada, Italy, Spain, Germany, France, Chile, Peru, Bolivia and Ecuador, allowing more wealth to shift from workers to owners.3

With profits flowing from across the world into the City of London and Wall Street, bankers had the resources to gamble. For example, derivatives, originally a device to protect farmers from fluctuating commodity prices, were created to bet on currency exchange rates. Soon there were derivatives of derivatives of derivatives, bringing the market’s notional value to 700 trillion dollars in 2011. The creation of complex devices, like ‘credit default swaps’ and ‘collaterized debt obligations’, was an essential part of this financial turn, allowing wealth to massively exceed what national economies could physically produce. But the unregulated build-up of these complex devices, or what is termed fictitious capital, led to chronic instabilities. ‘[Crisis is] a regular [feature] of the system that has been in place since the early 1970s,’ according to a report commissioned last year by the German investment bank Deutsche Bank.

Amid this talk of profits out of thin air, it must not be forgotten that financialization is a form of class power. It does not really create profit out of nothing but lengthens the ‘chain of indebtedness’ between workers and their creditors.4 One feature of financialization is that it penetrates social life, as households spend more on mortgages, consumption, education, health, while individuals become connected to financial assets through their pension and insurance schemes. This goes hand-in-hand with the retreat of the public provision of services under neoliberalism: as governments build fewer social homes, more people take on private mortgages, creating revenue streams which are financialized. Costas Lapavitsas, in Profiting without producing, describes this process as the simple ‘transfer of personal income directly to the profits of financial institutions’.5 And nothing made the iniquitous dynamic between people and finance clearer than the response to the financial crisis.

Socialism for the rich

First, governments stepped in. Between 2007 and 2008, the amount that taxpayers put into the financial system in the Global North was equivalent to 50.4 per cent of the world’s GDP, according to the IMF. This created budget deficits, which were ‘tackled’ by means of austerity programmes, transferring the cost of the crisis onto the less privileged sectors of society. Second, central banks engaged in an extreme form of monetary policy called ‘quantitative easing’, adding trillions of dollars’ worth of bonds to their balance sheets, which, in turn, reduces the cost of borrowing for banks. But persistent uncertainty in the economy has meant this extra cash has gone into short-term speculation rather than long-term investment: gambling with property prices and playing with stock prices to inflate executive salaries (see box: ‘The global economy since 2008’). This is how, to quote those anti-capitalists at Deutsche Bank again, the spoils of quantitative easing have been ‘distributed… to capital rather than labour’.

On a regulatory plane, political systems, which became increasingly in hock to financial interests since the 1970s, have done little. ‘The Basel Committee on Banking Supervision tinkered with some post-crisis reforms, but made no suggestions for structural changes,’ according to leading analyst and activist Ann Pettifor. Obama’s Wall Street Reform Act amounted to cosmetic changes, with the chair of Goldman Sachs baldly announcing that the Act’s biggest beneficiary ‘is Wall Street itself’. Now, even that is being watered down under Trump. As the satirical newspaper The Onion noted with a headline in May 2018, after the relaxation of banking regulations: ‘2024 Financial Collapse Passes House 258-159’.

Britain’s Vickers Reforms which recommended separating investment banks – which gamble with fictitious capital – from high-street banks, has yet to be implemented; Vickers himself recently told the BBC that Britain ‘would be in huge trouble if a very large, complicated banking institution got into trouble’.

What is to be done?

An irony of the crisis is that it was the most dispossessed of US citizens – black, Latino and female workers with little to their names but debt – whose position at the bottom of an upside-down pyramid triggered a global meltdown. Ordinary people do have leverage, the question is working out how to use it. One innovative tactic was sketched early this year by Greek former finance minister Yanis Varoufakis: millions of people pay utility bills to private companies that have been financialized, which ‘have already sold to financiers the next 20 years of the electricity bills that [they] will be paying’. If a direct-action movement could work out which financial derivatives, which specific CDOs, are ‘packaging the bills in a particular neighbourhood’, then payment strikes, organized over the internet, could be effected in such a way as to ‘explode those CDOs and make them bankrupt’. Turning financial instruments against themselves, shifting the site of resistance from the workplace to the home, could open up new levers of resistance.

Who will be giving the orders in the wreckage of the next crisis, especially if the central bankers are this time at fault?

Likewise, an intellectual revolution is needed in the economists’ profession. One nostrum to dispatch concerns the nature of money. Neoliberal economists focus a lot on the way central banks print money, but little on the way most money actually comes into being in the economy, which is via the private commercial banking system in the form of debt. This is what happens every time the bank grants a (dodgy) mortgage: it creates credit out of air. Increasingly, unorthodox economists, like Leo Panitch and Sam Gindin, are advocating that this power be placed under democratic control. Socializing the financial system and treating it as a public utility, like gas or water, would allow ‘the distribution of credit and capital to finally be undertaken in conformity with democratically established criteria’. This, in Ann Pettifor’s phrasing, would ‘subordinate bankers to their role as servants of the economy’ so that only environmentally sound and productive investments are financed.

There is a danger in focusing too much on the spectacle of the ‘crisis’, when the daily experience of life under financialization (see article ‘Home Sweet Home’, also in issue 514 of New Internationalist magazine) is a crisis too. Still, global seismic events are revelatory because the interests of power become nakedly clear. Ten years ago, it was Ben Bernanke, chair of the US central bank and Henry Paulson, secretary of the Treasury, who told a confused, diffident President Bush what was going to be done: massive state intervention to save the financial sector.

Who will be giving the orders in the wreckage of the next crisis, especially if the central bankers are this time at fault? (see article ‘The Great Unwind’, also in issue 514 of New Internationalist magazine) Whatever the answer, the blame must not be laid at the feet of migrants, workers and the marginalized, but on those enabling, creating and profiting from a rapacious and crisis-prone financial system. So, what will trigger the next crisis? Time to make like the financiers themselves, and speculate…